Working Paper: NBER ID: w21471
Authors: Eswar Prasad; Boyang Zhang
Abstract: We develop a two-sector, heterogeneous-agent model with incomplete financial markets to study the distributional effects and aggregate welfare implications of alternative monetary policy rules in emerging market economies. Relative to inflation targeting, exchange rate management benefits households in the tradable goods sector but in the long run these households are worse off due to higher consumption volatility. A fixed exchange rate reduces the welfare of these households and aggregate welfare when the economy is hit by positive shocks to nontradable goods productivity or foreign interest rates. Fiscal policy can more efficiently achieve similar short-run distributional objectives as exchange rate management.
Keywords: Monetary Policy; Emerging Markets; Distributional Effects; Welfare Implications
JEL Codes: E25; E52; E58; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| nominal exchange rate management increases consumption volatility (F31) | long-run welfare for households in the tradable goods sector (D69) |
| long-run increase in consumption volatility (E21) | long-run welfare for households in the tradable goods sector (D69) |
| exchange rate management (F31) | short-run consumption for households in the nontradable goods sector (E20) |
| exchange rate management (F31) | long-run welfare for households in the nontradable goods sector (D69) |
| fiscal policy (E62) | welfare improvements (I38) |
| nominal exchange rate management (F31) | short-run welfare for households in the tradable goods sector (D69) |